Opinion

China’s state-owned enterprises reform still lacking bite

China has gone through a remarkable transformation in recent decades but tough reforms have become rare, especially since the global financial crisis. Among the many reforms announced since President Xi Jinping's administration took office in March 2013, the most significant for China's economic outlook undoubtedly will be the reform of state-owned enterprises (SOEs).

By: and Date: October 4, 2016 Topic: Global Economics & Governance

This op-ed was originally published in Nikkei.

nikkei

Large SOEs are known for their low efficiency, heavy debt loads and poor corporate governance. Returns on assets have been decreasing in China over the last few years and are now lower than those of most emerging economies. This could reduce the country’s growth unless action is taken.

On July 26, the State Council issued new guidelines on reform of central government-owned companies. The aim is to classify SOEs into four groups — strategic, innovative, to be consolidated and to be cleaned up — according to their sector and to clarify the outlook for each group by 2020.

The new outline however may not provide a smooth pathway to improve efficiency or reduce moral hazard. Nor does the policy guideline necessarily mean there will be a Darwinian winnowing of unviable entities. In fact, closer examination shows that there were few references to unviable SOEs that need to disappear.

All in all, the policy outline has too few sticks and too many carrots to change the behavior of SOEs.

A reduction in the size of SOEs does not seem to be a key objective, which means that the crowding out of the private sector by the public sector looks to be here to stay. In fact, only the very small part of the SOE universe classified in the guidelines as “to be cleaned up” — is set to shrink. This boils down to just the steel and coal industries and only accounts for 5% of total SOEs. China’s overcapacity problem extends well beyond these two sectors.

Moreover, there are growing signals that Beijing will not allow further defaults by SOEs in these two sectors and that the government prefers alternatives such as injections of bank capital and debt-for-equity swaps. Consolidation is another more favored option even for industries suffering from overcapacity and marked for cleanup, as seen in the announcement Sept. 21 that Baosteel Group will merge with Wuhan Iron & Steel Group.

Not convincing

The new reforms do open the door to private capital but only for companies put in the innovation group. This is a narrower opening than what was announced at the National People’s Congress session in March 2014.

Some 45% of central government SOEs have been classified as strategic by their asset size, which indicates the government will definitively retain control of a big chunk of state companies. Furthermore, no clarification has been given to the meaning of private participation as the word “control” was carefully avoided in the State Council’s statement.

It will not be easy to convince private investors with such unclear guidelines. This means that more will need to be done to attract capital, especially in an environment of very low returns on assets. Unless there are further clarifications or additional sweeteners forthcoming from the government, public-private partnerships will remain sporadic.

While the cry for reform is loud, the reality is that SOE investment still supports China’s economic growth. Fundamental reform would be too disruptive in the short run and long-term benefits are not the key consideration for the Chinese government now. There is indeed a trade-off between reform and short-term growth, and Beijing has made growth its priority.

Although there would be clear benefits in terms of resource allocation and an increase in returns on assets, the cost of funding for SOEs would increase if there were real restructuring. It is evident the role of the state in production will not be reduced any time soon in China. In fact, the assets of SOEs have only increased in the last few years compared with those of private companies.

The thunder of reform has been loud, but the rain has been rather light. The government continues to drag its feet on SOE reform and the liberalization of markets. The disappointing guidelines on SOE reform fall short of the needed Darwinian action to improve efficiency and returns on assets. Meanwhile, lax monetary policy will continue to feed the liquidity needs of government-owned companies, especially in overcapacity industries.

Via mergers, the consolidation process will continue but China will end up with even larger SOEs this way. Given that these mergers will be politically driven, efficiency gains cannot be expected and the companies will become much harder to manage. As SOEs become even larger, the risk of crowding out the private sector only increases. In this scenario, we should not expect returns on assets in China to increase anytime soon, to the detriment of the country’s potential growth.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article More by this author
 

Opinion

Why China should fear the EU's carbon border tax

Expect Beijing to soon start lobbying against the proposal.

By: Alicia García-Herrero Topic: Energy & Climate, Global Economics & Governance Date: July 26, 2021
Read article More on this topic More by this author
 

Opinion

Could the RMB dislodge the dollar as a reserve currency?

The dollar remains the world’s largest reserve currency, but it is facing both domestic and external risks.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: July 14, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

CCP's 100th Anniversary: Reflecting and looking forward

As the Chinese Communist Party celebrates its 100th anniversary, we looked into the past, future and present of the country's economic development.

By: The Sound of Economics Topic: Global Economics & Governance Date: July 7, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

Challenges and growth of China's private sector

Is the dynamic role of the private sector in China under threat by its economic model and the United States?

By: The Sound of Economics Topic: Global Economics & Governance Date: June 9, 2021
Read article
 

Blog Post

For the climate, Asia-Pacific must phase out fossil-fuel subsidies

An exit from coal in the Asia-Pacific region is a global decarbonisation priority.

By: Alicia García-Herrero and Simone Tagliapietra Topic: Energy & Climate, Global Economics & Governance Date: May 31, 2021
Read article More by this author
 

Parliamentary Testimony

House of Lords

The UK’s security and trade relationship with China

Testimony before the International Relations and Defence Committee at the House of Lords, British Parliament on the UK’s security and trade relationship with China.

By: Alicia García-Herrero Topic: Global Economics & Governance, House of Lords, Testimonies Date: May 27, 2021
Read article Download PDF More on this topic
 

Policy Contribution

How difficult is China's business environment for European and American companies?

Contrary to some narratives, China's business practices have improved, with a business environment that is generally more favourable than that in other large countries at similar levels of development.

By: Uri Dadush and Pauline Weil Topic: Global Economics & Governance Date: May 26, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

New kid in the playground: China's antitrust push

How is China’s antitrust push being weaponised to counter western sanctions?

By: The Sound of Economics Topic: Global Economics & Governance Date: May 12, 2021
Read about event More on this topic
 

Past Event

Past Event

Global value chain reshuffling: From tight coupling to loose coupling?

As the focus shifts from efficiency to resilience in global supply chains, what does this mean for China?

Speakers: Erik Berglöf, Alicia García-Herrero, Niclas Poitiers and Kristy Tsun-Tzu Hsu Topic: Global Economics & Governance Date: May 11, 2021
Read article More on this topic More by this author
 

Opinion

Europe's crusade to fend off Chinese interference falls short

It is in everybody's interest for China to level the playing field among state-owned, private, and foreign companies so that no new distortionary measures need to be taken elsewhere.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: May 10, 2021
Read article More on this topic
 

Blog Post

China’s M&A activity rebounds with a clear focus on Europe

Despite the pandemic, China’s interest in overseas M&A started to rebound in late 2020, with European industrial companies still of particular interest.

By: Alicia García-Herrero and Jianwei Xu Topic: Global Economics & Governance Date: May 4, 2021
Read about event More on this topic
 

Past Event

Past Event

Form a climate club: United States, European Union and China

Can the three biggest economies agree a carbon tax on imports to catalyse climate action globally?

Speakers: Simone Tagliapietra, Sheldon Whitehouse and Guntram B. Wolff Topic: Global Economics & Governance Date: May 3, 2021
Load more posts